Q&A: Should you sell a house or let heirs deal with it? The taxes shake out differently

Dear Liz: My mother, who will be 101 later this year, is leaving me real estate in her trust. The value of it is $4.5 million. She has other assets that will put her estate over $5 million when she passes. I currently have an offer from someone who wants to buy the real estate. Is it better for her to sell it now and reduce the value of her estate? She has never exercised the option for the one-time sale of her primary residence tax free. What are the tax implications if it remains in her estate until she passes?

Answer: There’s no such thing as a one-time option to sell a home tax free. Decades ago, homeowners could defer the recognition of taxable gain if they bought another house, and homeowners 55 and older could exclude as much as $125,000 of gain. That was a one-time deal, so perhaps that’s what you’re remembering.

Since 1998, however, taxpayers have been able to exempt as much as $250,000 of capital gains from the sale of their primary residence as long as they owned and lived in the home at least two of the prior five years. Taxpayers can use this exemption as often as every two years.

Clearly, your mom needs to find a source of good tax advice, such as a CPA or other tax professional. If you have the authority to act on your mother’s behalf through a power of attorney or legal conservatorship, then you should seek the tax pro’s advice as her fiduciary.

Under current law, if she retains the real estate it would get a “step up” to the current market value as of her death. That means all the appreciation that happened during her lifetime would never be taxed. If she sells now, on the other hand, she probably would owe a substantial capital gains tax bill, even if she uses the exclusion. The tax pro will calculate how much that’s likely to be.

That tax bill has to be weighed against the possibility that her estate could owe taxes. The current estate tax exemption limit is $11.7 million, an amount that will continue to be adjusted by inflation until 2025. In 2026, the limit is scheduled to revert to the 2011 level of $5 million plus inflation. President Biden has proposed lowering the limit to $3.5 million and modifying the step up, but those ideas face stiff opposition in Congress.

An estate planning attorney could discuss other options for reducing her estate if she’s still with us as 2025 approaches. The tax pro probably can provide referrals.

Monday’s need-to-know money news

Today’s top story: Are cash offers better for home sellers? Also in the news: A new episode of the Smart Money podcast on savings tips and the Child Tax Credit, 4 smart insurance moves for hurricane season, and how to find unclaimed money that’s owed to you.

Are Cash Offers Better for Sellers?
An all-cash offer for your home might seem like the golden ticket, but take the time to weigh all your options.

Smart Money Podcast: Savings Tips and Updates to the Child Tax Credit
Saving money can involve both cutting expenses and knowing how to make saving easier for you.

4 Smart Insurance Moves to Make for Hurricane Season
Checking your coverage and deductibles in advance can help you protect yourself financially.

How to Find Unclaimed Money That’s Owed to You
Finding your unclaimed property.

Monday’s need-to-know money news

Today’s top story: The pros and cons of selling your home to an iBuyer. Also in the news: A new episode of the Smart Money podcast on travel insurance and buying an electric car, 5 pandemic credit card habits to carry forward, and preparing your wedding budget for the reception resurgence.

Pros and Cons of Selling Your Home to an iBuyer
Figuring out your priorities — such as having a flexible schedule, getting the best price or minimizing stress — can help you decide whether selling to an iBuyer could work for you.

Smart Money Podcast: When Travel Insurance Is Worth It and Buying an Electric Car
What it offers, how much it costs and when you should purchase it.

5 Pandemic Credit Card Habits to Carry Forward
Among credit card holders whose credit limits were cut during the pandemic, 93% say their financial views or strategies changed because of it.

Is Your Wedding Budget Ready for the Reception Resurgence?
Wedding celebrations are back.

Q&A: This $1 house deal comes with elder care responsibility. It could get complicated

Dear Liz: My father-in-law died recently. My mother-in-law is not well enough to live alone. My husband has a brother and a sister who would like my husband and me to buy my in-laws’ big, old home for $1, take care of my mother-in-law 24/7, and make 60 years’ worth of updates and repairs to the house. I see plenty of downsides to this arrangement, but no upside. Is there a way this deal can work for us, and not just for the other siblings?

Answer: The upside is that you would own the house. Although the home may not be in great shape, it presumably is an asset with some value. Whether it has enough value to be worthwhile, and whether you want to acquire it this way, are open questions.

If you and your husband buy the home for $1, the IRS will assume that your mother-in-law gave the two of you her property, and that can be problematic. The difference between the sale price of the home and its fair market value would be treated as a gift for gift tax purposes, said Mark Luscombe, principal analyst for Wolters Kluwer Tax & Accounting. Your mother-in-law probably wouldn’t owe gift taxes, but she likely would have to file a gift tax return, and the gift would use up part of her lifetime gift and estate tax exemption.

If the home is a gift, you get her tax basis, as well. If instead she bequeathed the home to you and your husband in her will, the home would get a new, stepped-up value for tax purposes. How big a deal this might be depends on a lot of factors, including which state the home is in, so you’d need to consult a tax professional for details.

On the other hand, taking title to the home before your mother-in-law dies ensures that you and your husband actually get this asset. If it’s left in a will, your mother-in-law could change her mind and leave it in full or in part to someone else. If she doesn’t have a will, the house would be divided according to state law, which probably means your husband would have to share the asset with his siblings.

There are other aspects to consider. Taking care of another person can be costly: Caregivers spend nearly 20% of their personal income on out-of-pocket costs related to helping a loved one, according to an AARP study in 2019.

Also, more than half of family caregivers adjust their work hours by taking time off, reducing their hours or quitting altogether, AARP researchers found. In addition to losing income, they can lose promotions, job security and opportunities to save for retirement.

Caregiving also is associated with higher levels of stress, worse health and increased risk of death, according to the Centers for Disease Control.

Before you take on this task, consider hiring a geriatric care manager to help you assess your mother-in-law’s needs and discuss alternatives. You can get referrals from the Aging Life Care Assn.

Wednesday’s need-to-know money news

Today’s top story: How a mortgage nerd bought a house in a seller’s market. Also in the news: Why you should consider a second city trip in 2021, what changed while you were ignoring travel, and why travel is more expensive this summer.

How a Mortgage Nerd Bought a House in a Seller’s Market
Buying a house was super-hard, and I write about homebuying for a living. If you’re wondering how to pull it off, you’re not alone. Here’s what I did.

Why You Should Consider a ‘Second City’ Trip in 2021
Travelers are less interested in visiting big cities this summer. Here are some good alternatives.

What Changed While You Were Ignoring Travel?
Catch up on what happened in the travel industry while you were staying home.

7 Reasons Travel Is More Expensive This Summer
A look at the prices.

Q&A: Taxes on a home sale

Dear Liz: My wife wants to sell our home of three years for a $300,000 profit after an extensive remodel and move into our rental home. She wants to stay there for two years and then sell to take advantage of the capital gains exemption. If we do it her way, we lower our monthly mortgage payment but lose the yearly rental income of $30,000. Our income is around $130,000. Any input?

Answer: Each homeowner can exclude up to $250,000 of home sale profits from capital gains taxes if they have owned and lived in a property as their primary residence for at least two of the previous five years. Married couples can exclude up to $500,000. This tax break can be used repeatedly.

The federal capital gains tax rate is currently 15% for most people, so the full $500,000 exemption could save a seller $75,000 in federal capital gains taxes. If your state or city has an income tax, you could save there as well. California, for example, doesn’t have a capital gains tax rate, so home sale profits would be subject to ordinary income tax rates of up to 13.3%.

The math is a little different when you move into a property you’ve previously rented out, said Mark Luscombe, principal analyst for Wolters Kluwer. Over the years, you’ve taken tax deductions for depreciation of your property. When you sell, the Internal Revenue Service wants some of that benefit back, something known as depreciation recapture.

When you sell a former rental property, some of the gain will be taxed as income, even if you’ve converted the home to personal use, Luscombe said. The maximum depreciation recapture rate is 25%.

A tax pro can help you figure out the likely tax bill. Any tax savings would be offset by the net result of a move, such as the lost rental income (minus the lower mortgage payments) and the substantial costs of selling, including real estate commissions and moving expenses.

It’s not clear if you’ve already remodeled your current home. If you haven’t, please think twice about an extensive remodel if you plan to sell, because you probably won’t get back the money you spend. Home improvement projects rarely return 100% of their cost. You’ll typically get a better return by decluttering, deep cleaning, sprucing up the yard or putting on a new coat of paint.

Monday’s need-to-know money news

Today’s top story: How you can recover from a bounced check. Also in the news: A new episode of the Smart Money podcast on pet scams and buying different home types, the mortgage outlook for May, and how to find out if you qualify for a monthly broadband subsidy.

How You Can Recover From a Bounced Check
If you’ve bounced a check, ask your bank if it can waive any fees you’ve incurred, and get overdraft protection.

Smart Money podcast: Pet Scams and Buying Different Home Types
Common scams people fall victim to and how to avoid them.

Mortgage Outlook: May Rates Are Just Waiting on a Trend
How April rates flipped the script.

Do You Qualify For a $50 Monthly Broadband Subsidy?
Millions without broadband now qualify.

Wednesday’s need-to-know money news

Today’s top story: 5 key credit card strategies for international travelers. Also in the news: How an iBuyer helps gets the timing right, missing the boat on SPACs, and how to plan for your student loan payments to resume this October.

5 Key Credit Card Strategies for International Travelers
People who spend a lot of time abroad should look for travel credit cards with international perks and partners.

The Property Line: How an iBuyer Helps Get the Timing Right
iBuyers let you make a non-contingent offer, set a flexible closing date and give you the power to buy with cash.

Miss the Boat on SPACs? It May Be for the Better
The SPAC party may be over, but if you missed it, you likely didn’t miss much.

How to Plan for Your Student Loan Payments to Resume This October
Only a few months left.

Q&A: Protecting home sales proceeds from taxes

Dear Liz: My friend has been diagnosed with Alzheimer’s and is now living in a secure assisted living facility. After a year in this home, his sister finally sold his condo. Her tax person says he will take a big tax hit. I say it is totally medically ordered and he’ll need the money for his current housing ($5,000 a month) until he dies. I also question whether part of that $5,000 should be deductible because it is only ordered because of his illness. Your thoughts?

Answer: Your friend may not be able to protect all of his home sale proceeds from taxation, but he likely will be able to protect some.

If your friend lived in his condo for at least two of the previous five years before the sale, he will be able to avoid tax on up to $250,000 of home sale profits. Even if he fell short of the two-year mark, he likely would benefit from IRS rules that allow partial exemptions when the sale is due to “unforeseen circumstances.”

Meanwhile, medical expenses, including some long-term care expenses, are potentially deductible if they exceed 7.5% of someone’s adjusted gross income. Assisted living expenses may qualify as deductible medical expenses if the resident is considered chronically ill, which means they cannot perform at least two activities of daily living (eating, toileting, bathing, dressing, getting in and out of bed and remaining continent) or they require supervision because of cognitive impairment, such as Alzheimer’s disease or other forms of dementia. The personal care services must be provided according to a plan of care prescribed by a licensed healthcare provider. Typically, assisted living facilities prepare such care plans for their residents.

Thursday’s need-to-know money news

Today’s top story: How the pandemic has shaken up retirement. Also in the news: 6 steps for financial spring cleaning, what to know if you’re listing your home in 2021, and how to avoid having to pay back the $3600 child tax credit.

How the Pandemic Has Shaken Up Retirement
When to retire isn’t always in our control, but too early an exit can bring financial instability.

6 Steps for Financial Spring Cleaning, Pandemic-Style
This year, spring cleaning includes reevaluating your budget, updating insurance and setting new goals.

Listing Your Home in 2021? Here’s What to Know
Roughly 1 in 6 (17%) homeowners plan on selling their home in the next 18 months.

How To Avoid Having to Pay Back the $3,600 Child Tax Credit
Find out how the credit works.